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Advisers might be incentivized to move clients into cash to bolster their fee

Cutting advisory fees for low-yielding cash positions might seem like the right thing to do, but the practice is also being challenged for presenting financial advisers with a major conflict of interest.

“If you're charging lower fees for cash and some bond allocations than you are for equity allocations, the suspicion will always arise when you move clients into equities that you're doing so to raise your fee,” said Bert Whitehead, founder of Cambridge Connection Inc.

Mr. Whitehead, as a member of the compensation committee at the National Association of Personal Financial Advisors, penned a memo last week challenging NAPFA to address the issue of fees based on investment allocations.

While it would be difficult to quantify, Mr. Whitehead said the practice of lower fees on low-yielding cash and bonds has gained popularity since the 2008 financial crisis when the Federal Reserve's quantitative easing program began holding yields to near zero.

In his letter to the compensation committee, he charged that the practice of setting fees based on underlying portfolio allocations is not only widespread, but often improperly disclosed to clients.

“There is continuing discussion about fiduciary responsibility and what it takes to be a fiduciary, and NAPFA tends to be on the side of what it takes to be a fiduciary,” he said. “I feel like a voice crying in the wilderness.”

Bill Prewitt, founder of Charleston Financial Advisors, and chair of the NAPFA compensation committee, acknowledged Mr. Whitehead's memo for “making advisers aware that there are other ways to charge fees, but there are conflicts no matter what, and some are worse than others.”

“I think the only way (the memo) would be actionable is to see if it provides any more insight into the different methods of compensation,” he added. “I don't think anybody can operate totally conflict free, but we can reduce the conflicts through disclosure.”

Across the advice industry, financial planners are embracing their own rationale for or against adjusting asset-under-management fees for different portfolio investments.

Satoru Asato, president of the advisory firm McNellis & Asato, charges no fees for allocations to cash and knows it is costing him income, but he believes it's the right approach.

“We're not there to manage cash, we're there to manage investments, and the cash is there for liquidity purposes,” he said. “That's the philosophy we have, even though we recognize if we charge for cash there's more revenue coming it.”

Mr. Asato said his firm earns 0.65% on $230 million under advisement, and he said many of his competitors average 0.75% on their assets.

“The difference is the cash they are charging clients to manage,” he said.

Asked about the potential conflict of interest of moving a client out of cash and into something like equities, on which he would charge an advisory fee, Mr. Asato said that would be unprofessional.

“There will always be temptations,” he said. “But, as a professional, you're supposed to do the right thing.”

Because some advisers are willing to cut fees for low-yielding cash and bond allocations, other advisers are finding it harder to justify not cutting fees in similar fashion.

“It's a financial advice fee, and the job doesn't get easier just because interest rates are lower,” said Randall Bruns, private wealth adviser at HighPoint Planning Partners, and director of public awareness at the Financial Planning Association's Illinois chapter.

“Conversely, financial planners shouldn't be paid more as a percentage of assets when interest rates are high,” he added.

John Scherer, principal at Trinity Financial Planning, recalls a client who fired him a few years ago for charging an asset-based fee on a static bond ladder strategy.

“He went to one of the brokerage firms where he was charged less for bond allocations,” Mr. Scherer said. “If I think it's appropriate for a client to hold cash or fixed income, I don't want them to question my judgment. Clients are certainly free to question my recommendations, but I don't want them questioning my motives.”

A lot of advisers point to wirehouse fee structures as at least partially driving the trend toward separate fees for cash.

“Cash is an asset class, but it seems like compliance departments haven't gotten that, because they see cash as risk-free, and therefore they think you shouldn't charge a fee for it,” said David Haraway, principal at Substantial Financial.

“I think it all stems from some of these advisers coming from brokerage firms, where you have to justify holding cash,” he added. “The fact is, we know that asset allocation is responsible for over 90% of a client's risk-adjusted return.”

Along those same lines, Mr. Haraway draws a comparison to the mutual fund industry, where expense ratios are never adjusted based on cash weightings.

“Just look at the FPA Crescent Fund, which is holding 40% in cash,” he said. “I love that fund, but they can't find anything to buy, and they aren't lowering their fees.”

While Mr. Whitehead might not be alone in his criticism of lower fees for cash allocations, he believes the broader fee-based industry will continue to support it as another way of luring commission-based brokers from the wirehouses.

“There are a lot of people who are not interested in upsetting the apple cart, because [supporting adjustable fees for cash] makes it easier to recruit people from the dark side,” he said.

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